What is staking in cryptocurrency?

How Staking Works

With the PoW algorithm, computational power is required to participate in mining. With the PoS algorithm, it's different: the user must own a certain digital asset. The basis of staking is the purchase of a digital asset, followed by its lock-up in a specific wallet. Typically, the lock-up takes no more than a few minutes. After that, the asset synchronizes with a specific ecosystem, and cryptocurrency mining begins. 

Sometimes, during staking, it may not be possible to withdraw the asset, but you won't need to do anything. You just need to wait for the predetermined time, after which you will receive a reward. Here you can draw a parallel with the banking system. There, you can also leave a certain amount of money in the bank, and after a while, you will be charged interest for it.

Crypto exchanges encourage the staking of cryptocurrencies by offering users the opportunity to participate in staking pools. The goal of participating in pools is to increase earnings from staking by accumulating more coins in the pool (like a common piggy bank).

The more coins in the pool, the more transactions the node will receive for verification. And nodes are usually ranked by the number of coins they hold. Therefore, nodes that hold more coins receive a higher reward. This explains why staking pools are so popular: the more coins in the pool, the higher the profit for each pool participant. 

Staking and Liquidity Pool 

Liquidity pools and staking share common features, as both involve placing assets to generate income. However, in staking, the user "freezes" their funds for a certain period to support the network's operation, receiving a fixed reward at the end of this period. 

In a liquidity pool, assets work differently: they are combined with the assets of other users to create a common reserve, providing liquidity for instant exchanges or loans. Owners receive rewards from transaction fees in the pool, making the income less predictable. Additionally, the liquidity pool is subject to the risk of impermanent loss – a decrease in the value of assets due to price fluctuations, adding variability and risks for participants.

Types of Staking

Staking can be considered an analog of a bank deposit, where a person places funds and earns income while the money is at work. The yield depends on the amount of funds invested and the time they remain in the account. The longer the funds remain locked, the higher the percentage.

Each blockchain platform can set its own rules and conditions for staking. The main types of staking include fixed, indefinite, and DeFi staking.

Fixed staking offers high returns for those willing to freeze their assets for a specific period (from a week to a year). For early withdrawal, only the initial amount is returned, without accrued interest. The rates for fixed contracts are usually higher than for other types of staking.

Indefinite staking does not have a fixed end date, and interest accrual continues until the user decides to withdraw their funds. Interest is accrued already on the first day after the funds are deposited, and payouts are made every 30 days. This type of staking is preferable for users who want to maintain flexibility and access to assets.

DeFi staking is related to financial services based on smart contracts, which allow for higher yields for certain tokens. This is achieved due to higher risks and increased competition for liquidity in a decentralized environment. DeFi projects are interested in attracting users and are willing to pay higher yields for this.

Risks of Staking

First and foremost, these are cybersecurity threats that can lead to the loss of coins if they are stored on a crypto exchange or in an online wallet. To avoid this, investors use cold staking, i.e., storing coins on hardware devices – for example, on hard drives. 

Cold staking will protect coins from cyber-attacks, as the hardware device is not connected to the internet. On the other hand, there is a risk of losing or damaging the device. This is the downside of cold staking.

Another risk is related to the price drop of the coin stored in the pool. During the lock-up period, the coins cannot be disposed of, so you risk losing part of the principal amount (on which interest is accrued) because you cannot sell the coins in time to reduce your losses.

For some assets, the annual return may not exceed 5%. Such profit can be compared to a bank deposit.

Finally, there is a risk associated with the online availability of the node where the coins are stored. Typically, blockchains penalize the validator if the node cannot support transactions in the network, meaning your staking earnings will decrease in case of a validator failure. 

Liquidity Pool Arbitrage Strategy

The arbitrage strategy using a liquidity pool allows traders to profit from the price difference between the spot market and futures. The essence of this strategy is to take a short position (short) in the futures market while simultaneously purchasing the same tokens in the spot market. This action helps to reduce the risk from possible price fluctuations of the token, fixing the profit regardless of its future changes.

After purchasing tokens on the spot, the user adds them to the liquidity pool, where they begin to generate income from transaction fees. Thus, while the short position on futures is open, the assets in the liquidity pool continue to generate additional income. This allows for simultaneous profit from short positions and participation in the pool, even if the token price remains stable or changes within a small range.

An important aspect of this strategy is the precise calculation of potential earnings from the liquidity pool and consideration of risks such as impermanent loss. This scheme is particularly effective for highly liquid tokens, where the pool generates stable income, and the transaction fee within the pool covers any possible price fluctuations.

Conclusion

Staking in 2024 is a good opportunity for additional income, and it is completely passive. Many exchanges and platforms now offer profitable staking opportunities with a wide selection of digital assets. 

And as mentioned in the last chapter, staking and liquidity pools can be used for arbitrage, and Arbitragescanner can help you with this. There, you will find not only profitable cryptocurrency links but also blockchain analysis tools that the service's clients use to earn daily!